Want to Retire Early? Sorry, But Much of Your Net Worth May Not Help

In spite of certain political talk to the contrary, it’s pretty clear to most of us now that we’ve just come out of a recession. It’s likely that more and more Americans are feeling pretty good about their finances. It’s likely that folks haven’t been richer in many years than they are today, except for maybe in 2006 during the peak of the housing bubble.

It’s likely that folks are making decent money again and that they don’t feel like every day is a struggle to stay afloat. People might even be putting away some money for retirement and seeing their paper wealth begin to grow.

Except they’re doing it all wrong.

After reading this article, you aren’t going to like me very much. It’s going to start out informative, and I’ll show you how to calculate your net worth. Some of you will feel good about yourselves after calculating that number, and others will feel pretty lousy.

But then, I’m going to make most of the folks who read this feel lousy by pointing out why almost all of your wealth might be completely useless, why your net worth has almost no impact on your ability to make day-to-day decisions, and why you are really deep in a financial mess that chains you to your job and makes you a slave to money.

In this article, you are going to see what the difference is between net worth and useful net worth. You’re going to see how most folks under 40 with a goal of not being forced to work for a salary until the age of 59 and a half are in pretty poor financial shape and are taking almost no action to improve their positions.

Worse than that, they think that they are making the right choices in life. Choices that conventional wisdom tells us are correct and responsible.

Take a deep breath, and let’s dive in.

How to Invest in Real Estate While Working a Full-Time Job

Many investors think that they need to quit their job to get started in real estate. Not true! Many investors successfully build large portfolios over the years while enjoying the stability of their full-time job. If that’s something you are interested in, then this investor’s story of how he built a real estate business while keeping his 9-5 might be helpful.

Here’s a common example of how a typical American might track his or her net worth:

Sam has the following assets to his name:

A Honda Accord worth $20,000

A home worth $300,000

$7,000 in cash

$200,000 in retirement savings in a 401(k)

TOTAL Assets: $527,000

Sam also has the following debts:

A car loan of $17,000 on the Honda

A mortgage for $240,000 on his home

$4,000 in credit card debts

$30,000 in student loans

TOTAL Liabilities: $291,000

Sam’s Net Worth in this scenario is $236,000.

If you were to swap the word “individual” with the word “business,” then the financial statement that shows your net worth would be the equivalent of a company’s balance sheet. In this case, Sam is worth about a quarter of a million dollars and might be feeling pretty good about himself.

So, why is this number so important?

In and of itself, the net worth number is pretty useless other than as a vanity metric. But in that sense, it is VERY important. This is the first number that folks will think of when they calculate their financial positions. It’s a number that boils down exactly how many dollars they have to their name across all of their financial positions. It’s also the number that most folks try to increase as much as possible. This is unfortunate, as it leads to decision-making that would otherwise be considered irrational if net worth were looked at in a more intelligent manner.

Personally, I don’t care about my net worth as calculated in the example above because many of the numbers used to compile it are pretty meaningless. What do I care if I have $200,000 in retirement accounts? I’m 25, and I can’t access those funds until I’m of retirement age (30+ years into the future), so they do not have any direct impact on my day-to-day decision-making — or even really my long-term decision-making.

As my goal is to retire 30+ years in advance of the normal age, I care only about those aspects of my net worth that are directly relevant to my goal — that is, my usable wealth. Usable wealth is ONLY that wealth that will impact my goal of retiring early and excludes much of Example Sam’s net worth.

Now, that said, it is certainly useful to remain up-to-date on your holistic financial position. You should (and I certainly do) keep an eye on the value of your retirement accounts, home equity, car, etc. If you aren’t paying constant attention in this game of finance, you will lose. Whether through theft, ticky-tack fees, or by making an obvious mistake, those who do not closely watch their assets and where their money is going slowly lose in the game of money.

If you don’t know your net worth at the moment and regularly check up on it, then this might be one of those tasks that you set about completing immediately at the conclusion of this article. There’s no point in playing the game of finance if you can’t even keep score.

Two Types of Net Worth

As I’ve already alluded to, as far as aspiring early retirees are concerned, all net worth is not created equal. If you plan to retire before 40 years old, then money in 401(k)s and other IRAs might as well be on the moon. You’ll get there someday, but it is not directly relevant to your goals. That’s the whole point of early retirement — to create a sustained state of passive investment income that covers your living expenses at an extremely young age and in an extremely short period of time!

Furthermore, when it comes to tracking net worth, we have to acknowledge that some of the things that most people call “assets” — like a car, for example — are in fact not relevant factors in pursuit of the goal of creating a state of financial independence. The same would be true for boats, collectibles, jewelry, electronics, etc.

The problem here is that while those kinds of assets may well be worth something, the fact that you are holding them means that you do not *intend* to sell them or use them to produce passive income to fund an early retirement. If I’m wrong about you and your personal situation and you do intend to sell these items in the near future (or expect them to increase in value), then feel free to include them in your statement of net worth!

But I’d argue that few people hold a boat or a car hoping to sell it at a gain down the line and make a profit on their boating/fishing hobby or daily commute. And if you are collecting baseball cards or art in order to build wealth, then you might want to get your personal finance advice somewhere else.

Perhaps painfully, if one has debt on a car, boat, or other item similar to those described, that debt does get included in the net worth calculation. You still have to pay the car loan, regardless of whether the car produces investment income that enables financial freedom.

This is why buying luxuries on credit is such a drag on middle class America’s finances. Financed cars, boats, trucks, TVs, computers, and the like are a double whammy, as they are not assets that serve the goal of financial freedom, and the debts must be counted against their financial position.

Following my logic, we face a conundrum. On the one hand, assets like cars, boats, jewelry, and retirement accounts do have a real value, and we would be wise to keep an eye on their value over time to aid our decision-making processes.

On the other hand, they are not relevant to our goal of financial freedom at an extremely early age.

My solution? I track BOTH types of net worth — I track my total net worth, including all of my assets/luxuries and retirement accounts in one application, and I track only that net worth relevant to my goal of financial independence in the other.

Calculating Usable Net Worth

We’ve already demonstrated how to calculate the first type of net worth above. Here’s how Sam would calculate his usable net worth under my philosophy:

How did this happen? Well, Sam made three key mistakes that far too many middle class Americans make:

He bought a financed car.

He bought a luxury home with a huge mortgage.

He failed to build any significant wealth outside of a retirement account.

Folks, this is likely what most of America considers to be a strong financial position! This is absurd. It is also why most of America is unable to get ahead. A lifetime of “smart” decisions, and Sam is in a $284,000 financial hole. Another way of expressing this is to say that Sam has $284,000 in debts against any ability to make big life decisions that would disrupt his current income or lifestyle. This is why Sam has no choice but to continue to work his job for decades.

So What Should Sam Do?

When most people ask the question, “How can I begin investing in stocks/bonds/real estate?” or “How can I start a business?” they do so from this position right here! The hard and painful answer to that question is this:

Accept the fact that your financial choices to this point in life have resulted in a several hundred thousand dollar hole, and slowly and steadily begin to climb out of it. Otherwise, you will struggle to do anything other than maintain your current position in life.

If he’s asking me, Sam needs to get serious about building wealth and make some drastically different choices immediately. Sam is not going to like any of this advice:

First, he needs to harness the $60,000 in his home equity by selling his home and moving into either a far less expensive one with a smaller mortgage, or renting and investing the entire $60,000 in proceeds.

Second, he needs to sell his car and buy a used one with $3,000-$7,000, cash.

Third, he needs to start paying down his personal debts and get them to zero.

Fourth, he needs to start saving a much larger percentage of his income so that he can begin investing in assets outside of his retirement account. Notice that I am NOT saying that Sam should forgo investing in a retirement account. That’s a personal decision, and there are smart arguments both for and against doing so. I AM saying that wealth in a retirement account is fairly useless for those that aspire to become financially free at an early age and that if the majority of your net worth creation is going on in that account alone, that you are in big trouble.

It is at this point that Sam will be in position to spend the next several years rapidly building real wealth that gives him real options in life. No longer will he be chained to that mortgage, job, and vesting 401(k) interest. Sam will soon have tens of thousands — and not too much later, will have hundreds of thousands of dollars — in real, tangible assets like stocks and bonds, investment real estate, and a sizable cash position. In a few short years, he could buy back all of his prior luxuries with cash and the option to walk away from work entirely for months or even years.

With a long enough grind and a smart investment strategy, Sam could even retire in just a few short years, living forever off of assets that are not locked away in retirement accounts!

Of course, I’m living in fantasyland.

Sam is not going to sell his house and cramp his style. Sam is not going to sell his car and do the same. Sam is not going to cut back on his spending so that he all of the sudden starts saving thousands of dollars per month outside of his retirement account.

No, the best we can hope for with this article is to help Sam at the very least understand that most of his assets are really liabilities — or at best, are useless, given his stated financial goals of achieving financial independence.

Sam hopefully will keep that in mind over the next few years, and when he gets a raise, simply will not correspondingly increase his spending. Instead, he’ll put most of that extra money toward paying down debts. After a few more years and a few more raises, Sam will have paid off those debts and begin investing outside of his retirement account.

In 10 years, when Sam sells his home, he’ll buy a very reasonable replacement instead of the biggest, fanciest one he can qualify for. Slowly but surely, his position will improve, and one day, he will finally have a truly positive usable net worth, and maybe, just maybe, he’ll bring some options back into his life.

Conclusion

Sam! I wish I could save you those decades. I wish I could impress upon you the financial consequences of your decisions in those early years and the abundance that could be yours if you let go of your biggest “assets” and harnessed the wealth you’ve trapped in them to produce real returns elsewhere.

But, in failing to do that, I hope at least that you begin to build a little wealth outside of your home equity and retirement accounts. I hope that you focus your financial strategy around increasing that wealth from now on, instead of buying useless or even actively detrimental “assets” that do not support your goals.

And I hope that eventually, slowly but surely, you are able to buy some freedom back into your life. I hope that you buy yourself the power to decide whether and where to work — and what you do during the best part of your day, during the best part of the week, during the best years of your life.

What are you investing in to prepare for an early retirement? Do you track your net work regularly?

Let me know what you think with a comment!

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About Author

A longtime fan of BiggerPockets and a Real Estate Investor managing his first property, Scott is the company’s Director of Operations. BiggerPockets is a BIG website, and Scott’s background in finance and big data analysis will be instrumental in the next phases of company growth and in helping to bring the resources of BiggerPockets to more investors worldwide. Scott is passionate about helping others build wealth and serving his community in whatever ways he can. In his spare time, Scott enjoys skiing, biking, and cooking, and he is a lifelong rugger.

81 Comments

Nicely done again, Scott! Example Sam sounds a lot like (upper?) Average Joe. Spends more time planning what fancy coffee to buy and vacation to go on than their financial health. Example Sam should downsize the house and lose the car payment, but unless a huge pain point arises (like a job loss), alas, years of mediocrity are in his future.

I’ve never heard of the usable net worth principle. I like it! Because I hit my freedom number so long ago I have very little tied up in retirement accounts and such that have to sit there for decades, eroded by fees. Also wasn’t feeling rich or trying to impress anybody so my home is modest (with a rental attached, of course). Freedom was more important than a large payment. I live right next to the nice neighborhood so I see how they all work, work, work for their house, boats, cars, etc.
This is one reader not disappointed by your article, but impressed with the information. I hope many a new member reads it through. Well done!

So am I suppose to be impressed with the worst recovery in modern day history after a reccession? It’s seems this article started out political… Please bring on 4 more years of this awesome economy ????

That was just the opening of my article – the point is that if you aren’t building the right kind of wealth now, you might be in trouble because times probably won’t improve that much more, and banking on things getting even better might be a big mistake.

Good one. It’s all true.
Recommend a dispassionate evaluation of the “why” the goal and the systems to achieve. If done properly it will be reached. Started a little later but I’m nearly there myself. All worth it. Thanks for the honest evaluation.

“This is why Sam has no choice but to continue to work his job for decades.”

Newsflash: Sam is probably married. Sam probably has children. Sam probably wants his family to live in a nice house, in a nice neighborhood, with excellent schools.

I am going to go out on a limb here and guess that the author is a single fellow with no children. I would humbly submit that, generally speaking, priorities change when you get married and have kids.

My wife likes to live in a big fancy house with sky high property taxes, drive fancy BMW’s that get horrible gas mileage, buy fancy clothes to put in her huge closet, wear diamond bezeled Rolex watches and take MULTIPLE fancy vacations every summer (this summer it was SoCal, Detroit/Harbor Springs/Mackinac Island, Tampa/Clearwater, Blue Ridge Mountains, North Carolina, and headed to Charleston in August) and again for Spring Break (SoCal) and Christmas Break (Florida).

My 13 year old daughter DEMANDS that we attend every U of Cincinnati football game, no matter if the game is in Houston, Philadelphia or Tampa!!! Bearcat to the core!

I like Porsche 911’s. And Rolex Watches. And Armani suits.

I also like to work.

Am I a slave?

DL

p.s. I truly do not understand the author’s obsession with retiring so “early.” Is Josh really that horrible of a boss?

Definitely. X3. You asked. Congrats?
Life and wife choice. Some of us are married and still free.
On behalf of our consumet-driven economy, thank you, DL! My purchasing apt buildings sure hasn’t helped there. Keep up the good work!

Your welcome. I am glad that I have been doing my little bit to help out the economy. : )

Like David Greene (BP Podcast 169) I worked OT at my SoCal “Cop Job”, like a maniac, from my mid 20’s through my mid 30’s. Then I met my wife. Then my daughter came along. Then I got things right with God. My life completely changed.

As David Greene mentioned in his Podcast, the hourly OT rate for street cops in major cities in CA is pretty strong (about $75 per hour). Public Safety Budget is the single largest line item expenditure for Municipalities. Because of the sky high pension/insurance/benefits costs associated with police/fire employees, cities long ago figured out that it is way cheaper to pay existing employees OT than it is to hire additional safety employees… so like David Greene, I worked. A lot. The CALPERS Public Safety Pension formula is also pretty strong. The formula is 3% for every year worked and the Cap is 90%. So if you work 30 years, and your base pay is $110k, your annual pension will be $99k. $99k per year in SoCal will barely keep your head above water, but if you leave CA and go to a lower cost state, you can be comfortable…

Anyway, while I was single during the 1990’s, I purchased my first SFR for $130k (zero down VA loan, kept it as a rental), purchased my second SFR for $207k (zero down CALPERS loan kept as rental), purchased a 4 plex for $200k (10% down kept as rental), and purchased my third SFR (directly across the street from my second house) for $214k (10% down, rehabbed and flipped). I used that flip profit to buy a custom home lot for $162k cash. I sat on the lot until 2008 when the market crashed and contractors had no work. In 2008-2009, with the SoCal construction industry in chaos, we built a 5,018 square foot custom home for $386k, materials, labor, engineering, fees, and permits. I gathered bids, but my wife acted as the General Contractor, doing the day to day coordinating, for the 11 months of construction. ( I was still working my cop job of course )

In late 2014, I retired from the PD and in 2015 we sold that house for $740k and moved to Cincinnati. We have also sold all of the other SoCal houses and we traded the SoCal 4 plex (I bought it in 1998) for a 39 unit in suburban Cincinnati via 1031 Exchange. BP Member Bill Exeter’s company, Exeter Exchange, handled the transaction and they were awesome.

We effectively “traded” a $3,400 per month gross rents SoCal 4 plex for a potential $17,550 per month gross rents (plus laundry) Cincinnati property. The BP “Net Worth Disciples” will tell you that I am an idiot for trading “California Appreciation” for “Midwest Cash Flow” and a pile of money. We are quite happy with the “Midwest Cash Flow” and the pile of money.

I am going to die. I don’t care about “Net Worth”. I want to be able to enjoy my life now. To each his own. : )

I have $1.2m life insurance on myself, three policies, spaced out to mature when I am 70, 75 and 80. and when I die, my wife will get 50% of my police pension for the rest of her life… So it’s not like I am being reckless with my family’s future.

and yes, I finance all of our cars, except for my 2000 Ford E350 17 ft box truck (used, 247,000 miles!!! paid cash) and my 2012 Ford Transit (used, only 9,500 miles!!!, paid cash). Not to beat a dead horse, but when money is offered at 1.99% or 2.99%… !!!!!

Hi, it looks like you have done very well for yourself. Smart choices and smart investments. I don’t get however what the argument is here about. As it seems from reading your comment, you have done exactly what the author suggest we do. Creating active wealth which provides passive income so if we wanted we could quit our job or do something we love without the stress of earning to provide the basics. So if we follow the authors thought procedure, were really successful at it, we could be like you.

Steve, your very welcome. I’m glad to do my part to keep the consumer driven economy humming along. : )

As a matter of fact, I think that maybe I am doing MORE than my part.

There are five (5) Home Depot’s in Cincinnati. The Highland Avenue store is the highest volume store of the five in Cincinnati. I am one of the “Top 30 Highest Volume Customers” at the highest volume store in town.

I know that you guys hate credit, but because of my relentless, crazy consumer driven spending, I’m able to get 24 months interest free terms through HD Credit, every time I begin a rehab of an apartment. Or 18 months, or 12 months, whichever I prefer. Just by asking.

Like the State of California, and the Federal Government, I am spending my way to prosperity. : )

DL – agree with you 100%. a wife and kids will change your outlook for sure! i realized that a year ago when my wife and i had our first child. Absolutely nothing wrong with wanting “the good life” and knowing that you’re going to need to work hard to get it. appreciate you’re post. thanks for pointing this out.

Hi DL – sounds like you have a different goal than the intended recipient of this blog post. If your goal isn’t to retire early but to enjoy those luxuries, this won’t help you much!

I happen to love my job and stay up late writing articles like this one for the blog here, not because I have to, but because I want to. I plan to do this for a long time to come, even after I become financially independent, as many other staff members here at BiggerPockets also choose (including Brandon Turner).

I happen to be passionate about helping others achieve financial freedom. In pursuit of that goal, some of the assets mentioned in my article may be relatively useless.

Perhaps other authors on the blog may be better providers of the information you are looking for to achieve your goals.

DL – great hearing your story and agree on the wife and kids changing things. My wife and I have lived in a small multi for the last 4 years, but with our second kid here, we just bought a SFR home we hope to stay in for the next decade. You actually affirmed Scott’s article with the approach to acquiring assets which allow you to take the vacations and live the lifestyle you want.

Everyone has different goals in life. The one major issue in your plan is…. What happens if you cant work, ( job loss, physical illness??) How do those payments on the luxury toys and big house look now???
Compared to sam that has mailbox money coming in from rentals, when he sleeps.

Just a lil food for thought. The authors above plan is a mix of robert kiyosakis and dave ramsey rolled into one.

Anyway enjoy the lifestyle and hopefully you dont get caught swimming naked, when the tide rolls out!

If I get in the position where I can’t work anymore, I will rely on my CALPERS pension to pay my daily living expenses. (I receive 84% of my $105k base pay. There is a 3% COLA if inflation ever kicks in. lol)

While that amount would barely keep my head above water if we lived in SoCal, it goes a long way here in the midwest.

If you’re not interested in retiring early or your answer to that question is “no”, obviously the content of the article won’t resonate with you.

The article is written for people who DO want to retire early, but need a reminder that their financial actions may be preventing them from accomplishing that. You seem to have different goals — that’s fine.

Sometimes we have to make the hard choices. We do want nice things for us, and our family, yet if we take a short time to cut our expenses, use the funds to build income producing assets, how long before we have recovered enough to get that lifestyle back on track, while still producing funds for investing?

Give up a few of the nice things today, and tomorrow you can have even nicer things.

Good points here Scott, and while you did include a very solid beard picture, you aren’t exactly correct about retirement accounts. They can be accessed in a few different ways before “retirement age.”

I am fairly familiar with some of these strategies for harnessing retirement funds. The key to this article and the definition of a usable asset is “Intent” – most Sams don’t intend to use their retirement accounts for early retirement. If you are intelligently using systems to get to that money sooner, great! You can count that towards your usable net worth.

If the metric numbers used in real estate (e.g., COC, IRR) are the highway directional signs, then net worth is the destination. Net worth is a representation of ones financial health and is an essential tool in reaching financial independence. This article, and rightly so, points out that most people have trouble reading a “balance sheet,” and thus are unable to distinguish the difference between net worth and usable net worth; actually, I would argue that most people have never formulated their net worth.

One’s net worth is significantly more than a vanity metric; it is a roadmap to financial security. Our, it is a measurement of what remains after one’s bad habits are subtracted from their good ones. Either way, it is a metric that has allowed me to reach my “freedom number” at an early age. The freedom number is enough passive income that allows one to break free of the earned-income rat race. I’ve used it as the basis for many financial decision.

My net worth has increased 650 percent over the past 17 years. I lost 45 percent of my net worth between 2006 – 2009 due to the housing crises, which prompted me to sell properties in average markets and reinvest in foreclosed properties in great markets. This strategy helped regain 30 percent of my lost net worth in six years. My point is this, using net worth as a “scorecard” has helped me focus on areas critical to my financial security.

I’m a firm believer that money is about freedom. Personal liberty, in my opinion, is the paramount reason for accumulating wealth, and the net worth calculation is a vital tool in attaining that type of freedom.

Sam could sell his nice house,luxury cars and watches.
He could instead buy a used car (been there done that,believe me) and spend a fortune on repairs every 6 months that could easily exceed payments on a new car.
He could move his wife and 2 elementary school kids into a rental (what a terrible decision!) in a poor school district while struggling to save every single dime for the next 5 years so he can start finally building a heathy “useable net worth” portfolio…

I love my life and make sure to have lots of fun every weekend doing something to enjoy the mountains here in CO, the nightlife in Denver, travel, and otherwise have a great time. I find it interesting that so many people seem to think that life would be worse without certain financial choices – like buying a home. Certain choices are exceptionally damaging to one’s long-term financial position and it is NOT “either build wealth OR have a good life” – I’ve found it’s possible to build wealth AND have a good one.

I’m going to mostly disagree with this article due to how cheap it is to borrow money currently, the advantages of diversification (though he could diversify more – the vast majority of people work and can’t do much more then play the stock market though), and an absolute networth is useful for getting larger loans from the banks. They want to see those big numbers even if it’s tied up in a retirement account.

Selling a house incurs transaction fees, would make more sense to get a 90% HELOC

The problem is that the house is not an income producing asset, so taking out more debt against it would simply be exacerbating the problem IMO. But, you are right that if you can borrow against assets that are appreciating, great!

But you still have to live somewhere. Not everything you own is going to be income producing. Going off your approach to debt, then renting would be preferred due to not having any debt involved even if financially it can be a significantly worse decision. Owning a house is another form of diversification

Hi Adam – personal finance is personal. I’d just encourage folks to not lock up so much of their net worth in a primary residence. If your net worth is all in home equity, you are in trouble, and borrowing against that further might be risky. I’d prefer to rent cheaply than live in a fancy expensive home. But, if you live in a comfortable, affordable home with low payments, you’ll be alright I’m sure. The home is not an asset, however.

I do take debt out on my home – which is a duplex where I live in half and rent out the other. I believe that’s good use of debt.

Taking the equity out of the house is not exacerbating the problem. Simple question: if you can get money at 3% and invest it at 10%, how much would you want? All of it!

I agree with your main point about usable equity. I see way too many people that are retiring with better than 2/3 of their net worth not doing anything to contribute to their retirement income. But, all of the equity in a home can be put to work. The earlier you start, the greater the benefit by the time you retire.

I like Adrian’s strategy. Get the biggest HELOC you can and put that money to work. Create a nice simple interest rate arbitrage and watch the equity in your home actually start contributing to your retirement. Personally, I would put it into a high cash value life insurance policy and enjoy the simple arbitrage spread I’ve created. Then I would leverage the cash value into my real estate investments to create a second arbitrage spread.

Now a simple interest-only HELOC payment is controlling three different asset classes and creating wealth out of thin air.

Great comments and opinions. Scott, this was a very well written article. As with any article that involves personal finance, there are so many variables. Someone mentioned balance. And someone mentioned moving and having kids go to a lousier school (this not improving your current situation). All valid points. Although I don’t think Scott’s article hits me right between the eyes for MY family’s situation, it was useful to see in print and see something in a completely different light. My “net worth” (I feel) is decent for a 41 year old, but it’s definitely not “usable.” Tying to create a larger income stream (passively) is certainly the goal to be able to fund life in a ridiculously expensive state (CT). Sure, I could pick up and move to MS and buy a house for $40k, but would my children be safe; get a decent education? Would I be happy? Lots of variables. Thanks again Scott. We thank you for the article, even if it doesn’t fit perfectly with our personal situations.

Thanks Rick! Glad you found it useful – personal finance is personal! I just hope this gets some people thinking in terms of usable net worth instead of only building wealth in places where it is locked up.

Excellent and ouch! I’m not sure who else this hit, but it totally hit home for me. Thank you so much for your words of wisdom and advice. I needed this to awaken me from my stupor. Taking heed and moving forward towards true financial freedom.

My personal preference would not revolve around net worth. My philosophy is, “Control everything, own nothing”. What I do not own cannot be taken away from me through litigation, even it if provides a handsome income.

My advice is: invest for income, and spread that income across enough sources that losing an LLC in litigation, for example, does not take away a major portion of the income which comes to me through my business entity structure. If that happens, I draw on the resources in my business entity structure and replace that income by acquiring more income-producing assets.

Love it and totally agree. I think that the control everything own nothing is a little bit more useful for folks that have already built up a sizable net worth. I’ve found that it is substantially harder to invest through LLC’s for folks getting started than it is to own it under your own name – especially if you are house-hacking like I am. In a few years, I will begin transitioning my assets into LLC’s and diversifying my income streams, absolutely.

While I agree with the theme of this article, which is to say that generally focusing on income-producing assets is good and taking on too many liabilities is bad, there are some major flaws in the thinking.

I’m a CFP, and work with high- and ultra-high net worth clients regularly who are constantly searching for the most efficient way to 1. Grow their assets (highest rate of return given a certain level of risk) 2. Protect their assets (from taxes, creditors, liability) 3. Use their assets (for current and future expenses). The better you know the tax code and the more creative you get in your wealth planning, the more money you can keep in your pocket, grow, and use to your heart’s content.

My main gripe is what someone mentioned already in the comments section: The assumption that retirement assets cannot be used without penalty until 59 1/2 is just incorrect. You can access retirement account assets through what’s called Substantially Equal Periodic Payments (SEPP) through IRS code 72t. This basically allows you to access your money without penalty at any time before 59 1/2 provided you withdraw the assets according to a specific schedule, using life expectancy tables, for at least 5 years or until hitting 59 1/2, without drastically deviating from the schedule. Basically, it means you can take out a % without the IRS penalizing you. So, by your definition, your retirement assets are without a doubt “Usable Wealth” at any stage in your life.

You could use this SEPP tool and take it a step further. Through self-directed IRAs, you could take your retirement assets and invest directly into income-producing real estate which feeds income back into your IRA. You could then set up a SEPP for these accounts to access a percentage of the liquidity every single year.

And I agree with the other points made. Life isn’t all about simply retiring early or being financially independent at all costs. There are some extreme practitioners out there who skip out on life’s pleasantries – vacations, going out to eat, socializing, having hobbies that cost money, picking up the extra glass of wine or coffee – in favor of reducing costs as much as possible so they can “retire early,” whatever that means. (What will these people do once they are retired? One’s work helps give meaning to life – there is a lot of research around this showing the correlation between meaningful work and happiness – so hopefully you have some good ideas as to how you’ll spend your time once you’re financially free).

Instead of sacrificing everything, maybe be cautious with your expenses but not to an extreme, smarten up and know as much about personal finance as possible, and focus on raising the top line – meaning, focus on increasing current income as much as possible right now, which frankly can move the needle much faster toward reaching your financial goals than simply cutting out a few hundred dollars worth of expenses per month.

Balance is key. Those who can figure out how to have an incredibly rewarding life in the present while simultaneously setting their future selves up for prosperity are the ones who have it made. ; )

Thanks for this great information. I agree wholeheartedly with your last line.

Re: retirement accounts – it’s what you intend for the asset that determines if it is usable net worth. If you intend to unlock it early, great, it’s a usable asset. That, however, seems rare to me in my experience. Most folks do not intend to do that.

\”First, he needs to harness the $60,000 in his home equity by selling his home and moving into either a far less expensive one with a smaller mortgage, or renting and investing the entire $60,000 in proceeds.\”

I think that the problem with this is that even if he takes out a HELOC and reinvests at a higher rate, he’s ignoring the elephant in the room – he has a huge debt liability against an asset that typically just appreciates with inflation.

WANT TO RETIRE EARLY? was the title of this article and Scott lays out a way to do that. If you don’t wish to retire early, then continue to live in the consumer driven economy accumulating as many expensive things as possible with debt. When you do that, I know you won’t have enough money to invest in real estate and that just leaves more opportunities for the rest of us who do wish to retire early and are willing to forego some things in the short run so that we can “live like no one else” with freedom to do as we wish with our time and money. Balance is always key and each person has to do what works for their own family circumstances. Thanks for the article, Scott, and everyone else for your comments. I always learn so much when I visit BP!

Scott, I absolutely agree with the article (except for the part where it was suggested that Sam sell the house and move into an apt.) I paid off my house and car by the time I was 40 and you really can quickly accumulate wealth when you don’t have any debt, as mentioned.

I understnad that you can access those funds early. However, most people do not “INTEND” to use those funds for early retirement. If you do intend to use retirement or home equity to fund early retirement, then by all means count it!

Nice article, Scott. Your points are entirely valid, even people make different decisions from what you recommend.

I also track both kinds of net worth, though, to be honest, even my overall net worth calculation doesn’t include cars and jewelry. I only include “assets that tend to appreciate in value” as the authors of “The Millionaire Next Door” describe it (ruling out the cars), and only those things that would realistically be sold: selling my wife’s engagement ring would be a last resort after losing everything else, and I know that you don’t get full value for those types of items when you need to sell them anyway.

My net worth forecast, which is also updated each tax season for actual values, has an extra column for “usable net worth”. This is my “can I retire yet?” amount. Our home is never factored into this, and our retirement accounts don’t factor in until age 65 (here in New Zealand). This keeps it obvious and up front in terms of the retirement calculation and decision.

Interestingly, I recently read an article about how High Net Worth Individuals (HNWI) are identified here in NZ, and it doesn’t include the personal home either. 🙂

Now, when the bank wants me to fill out forms, will I throw the cars, etc. in there? Sure, but that’s for them, not me.

To be fair, we do also have the house with the big mortgage. Personal decision to take a break and build something for our family for the future. The commenters that say that outlook changes a bit when you’re married with kids, are correct. We don’t need the “best” schools, but we do want to be near very good ones for our kids. You don’t know when you’re going to drop dead, so you also have to live. Young and single is the best time to dig in, but we’ve made a lot of other sacrifices and are living on a tight budget despite our household income. The house is where we choose to spend our money, for now. The market here is also out of control so cash-flow deals are…not really a thing in any major centres (I don’t like to buy rentals in markets with less than 100k people – still cash flow deals in those areas, from what I’ve seen).

The key here, for me, is that we’re going in with our eyes wide open. We know exactly what restrictions the mortgage puts on us, and we know that the personal home is the thing that we could lose if something bad happens. (Rentals are cash flowing, so would only lose them if the bank calls in the loans randomly – high equity helps prevent this as well.) We therefore plan accordingly. Emergency fund to cover all costs for 6+ months to allow us to sell or me to find a new job if we’re talking job loss. Emergency fund also covers some medical expenses, and medical insurance covers higher medical costs, covering our downside. Etc. Point is, eyes open.

I think that you have a fantastic approach to finance and wealth and that you are doing it right – you have the personal home, but you also have significant assets outside it! So you know what you are doing, understand what you want and the cost of that.

Thanks for the article. And I understand Sam a lot. Here’s my question mainly pretaining to student loan debt. I remember playing Robert Kiyosaki’s Rat Race game on computer. Granted it is a very simplified version of getting to financial freedom but it highlighted a lot of investing principals. Basically, starting small and building up to larger investments mainly in Real Estate. One thing I always noticed is that I could never pay off the student loan debt because it would hinder investing. Eventually, when I had a few cashflow pipelines did I pay off the student loan debt just to take away negative cashflow.

So as a new investor do you recommend paying off student loan debt before real estate investing? Or get some cashflow streams to overcome the negative student loan cashflow? (fyi must of the student loan debt goes away within 10 to 25 years)

Alberto – this is another great question. I would say that it depends on your goals. If student loan debt is hindering your ability to invest and you do not think that you could earn consistent returns greater than the interest rate on your debt, I’d say pay it off. If you were going to do something that typically produces enormous returns on capital invested (like house-hacking, for example) it would make more sense to do that, and then use the passive income to pay down the student loans.

Thank you for this. I’m looking into trying to invest at the moment. But I am interested in house hacking although it is a bit tough here in Los Angeles. I just started scrolling so I’m still wrapping my head around all the information.

This is a very thought-provoking and interesting article, regardless of whether you end up agreeing 100% with what assets are useful.

As a Private Banker, I look at the balance sheets and tax returns of “affluent” individuals all day long, and it’s very interesting to see the differences in how people account for their net worth. I’ve got some clients who list, say, $1M in real estate and $250K in stocks/bonds but then proceed to itemize in detail hundreds of thousands of dollars of their watch collections, automobiles, boats, art, guns, jewelry, etc. I laugh every time. Bankers literally scratch through those items and look at two things: liquidity (cash and stocks/bonds held outside trusts and retirement accounts) and debt obligations. These clients often “forget” to count as liabilities pesky little things like car loans and 5-6 figure credit card balances.

Other clients have to be prodded to remember to add assets like real estate and ownership percentages in companies to their net worth statements. They list cash and their home and tend to have no debt and 7 figures in liquidity. They don’t consider illiquid assets as particularly relevant and as a result often leave them off official net worth statements since they “don’t matter.”

Guess which clients are angry and overworked and which ones are jovial and carefree?

Wow Scott, you really struck a nerve with some people. I suspect that the reason comes down to a difference in personal “whys”. For myself, I want what money represents: time! I want control over my time so I can spend it how I choose. I won’t buy a new car, finance a new 4k curved tv, or purchase designer clothing. Plain and simple, I’m choosing to live a basic life in my 20’s so that I can live the rest of my life on my own terms. Most of my friends look at me like I’m crazy when I tell them that. Some people prioritize luxuries, which is great if that’s what they want. I want to build wealth. Plain and simple.

Yep – thanks David – I think that some folks are just less interested in the time that money buys and more interested in accumulating luxuries. Nothing wrong with that! Just not the audience that I write for.

Great article Scott! Some people don’t understand they are no the target audience unless they want to retire early. For me, and from your comments it sounds like for you too, early retirement is not about not working, but about being free to work any job you want, no matter how little it pays, or not work for a while and just enjoy life. It is funny how many people are telling you to enjoy life a little, that is the whole point of financial freedom! If your passive income can pay all your bills and then some, you can do anything you want! Personally I want to get to the place where I can volunteer for a year somewhere and still pay my bills. I own a duplex and live in one half and rent out the other. It isn’t in the best neighborhood but my kids still go to a great school and we are happy. Everyone has different priorities though! Obviously if your priority is not to be financially independent this article isn’t for you!

You sound like you might read Mr. Money Mustache? He focuses on early retirement, I read his blogs and also the FIentist who makes the distinction between early retirement and financial independence. People tend to think you are lazy and just want to sit around when you use the term early retirement, I like to use financial independence more after reading the FIentist.

Do you have articles about how to specifically retire early? I would be interested in reading more of your ideas!

Hi Nathan – fantastic comment. Yes, I read MMM regularly! I try to combine frugality with real estate investing (Actually, I thought of real estate investing, particularly house-hacking as simply an obvious way to live frugally by getting out of a mortgage). I think that as housing is your biggest expense, it’s also your biggest opportunity to expedite financial freedom, and write with a focus on building wealth through that medium.

I think that the biggest single thing that folks can do to change their financial situations for the better is to buy a house-hack close to work, and commute by bike (MMM). That single choice dwarfs pretty much every other financial choice you can make, and you don’t even have to be particularly frugal to save 50% or more of your income every month after you more or less eliminate housing and transportation expenses from your budget. So, while I’m not as frugal in some areas as I could be, I don’t have to be to come out ahead every month by a large margin.

If you click on my author bio at the bottom of the article, you can see more of my writing! Thanks for the comment!

Good article Scott. I think you’re generally correct that people should sacrifice early in their life to build wealth early and give themselves more options further down the road. But I think the commenters that have pointed out you need to do this in a balanced way are correct. A few points.

A) Having a goal to retire early is great but what will you do when you get there? There’s really only so much leisure activity you can enjoy and ironically I think the people that work hard and are able to retire early enjoy it the least. Instead I would encourage people to find work you love doing and plan on doing it at least part-time until you die.
B) I think buying a reasonably expensive personal residence in a sought after area is a good idea. I have made a lot of money from appreciation in just that way. Popular areas will generally stay that way so why not enjoy it AND make money? Also people are nuts if they’re not carrying a mortgage right now. I’m paying 3.5% AND getting the tax benefits. I don’t own a vacation property at the moment but I think that is a good idea as well for the same two reasons.
C) People should shelter as much money in retirement accounts as they possibly can. They are great wealth building tools and through loans and self-direction you can use that money today for real estate or other investments.

Can you provide an example of Usable Net Worth for someone who doesn’t have credit card debt, student loans, and car debit but also have rental properties but are financed and also brokerage accounts and a Roth IRA? I’m trying to understand what an ideal Usable Net Worth should look like. Are you only including assets that are income producing with the idea that you can sell off these investments without having a impact on your lifestyle? Also technically you can withdraw from your 401(k) but you’ll have pay a penalty tax so shouldn’t you actually include that number as an asset but include the income tax you would have to pay as well as the penalty? What about a Roth IRA? You can take out your principle without pentalty since you already paid taxes on it.

Maybe I am not fully understanding what Usable Net Worth is really supposed to be used for. Skimming through the comments, it seems to be used for ‘early retirement’ but if that’s the case the value of the rental property doesn’t matter – only the rental income matters no? If we’re talking about ‘regular retirement’ and withdrawing slowly from a 401(k), you would be selling off these stocks/bonds in small proportions in an amount that you need per year so the amount in your 401(k) slowing decreases. But in a hard asset you can’t sell proportions of real estate.

Overall I like the idea of not including your primary residence and car as an asset because you’re really not going to sell them and live nowhere and not have a means to get around but I’m not fully grasping how you would use the alternative net worth calculation. If you can enlighten me on how you would use it, I’d appreciate it!

I consider my rental properties to be parts of my usable net worth. I *intend* to use these properties to generate income and build wealth that I can access immediately, and until the day I die. The moment that they stop producing returns that are material to my financial position, become a headache, or otherwise no longer fit my needs, I will sell them and redeploy the equity. So yes, I count them towards my net worth.

I do the same with my brokerage accounts, cash positions, and if you do intend to harness retirement assets early, then you can count those too!

Usable net worth is that which you intend to use to increase the opitions that you have in the short, medium and long term and excludes wealth that can only be used in the very long term.

It’s all about living within your means. Everyone needs a budget whether they make 40,000 a year or 1 million a year.

If you make 100,000 a year but living on 75,000 then after taxes you are almost in a negative position.

If you make 500,000 and spend 100,000 a year you still have lots of money to keep investing. So while saving is important it is just as important to more important that you constantly learn to increase your value and annual earnings potential.

I agree with Joe – without knowing more about Sam it’s kind of hard to say what he “should” do.
Also, $300k is not a “really nice home” in many parts of the country – in any metro area in CA $300k gets you a dump in a war zone. If Sam is single, rent some of the rooms out. If he’s married with kids a good neighborhood has value, as does not getting mugged, shot or burgled.
$20k for a car? Keep it for 250k miles & $ per mile isn’t so bad. NEXT car can be 30k miles used – don’t take the hit on this one.
Retirement fund;
Maybe a Solo 401k rollover if he is self-employed? Other options that allow him to borrow against his retirement if his consumer debt it higher rate?

Haha, yes, I agree. You need to look at your situation and think about how you can begin shaping it toward where you want to be. This Sam fellow probably also needs to look hard at his budget and figure out how he can get more money toward paying down debt – starting with the car and then the mortgage. With some real equity in his home, he can re-consider his options. Is it more important to pay off the home or to borrow against it to purchase a rental property? It will depend on the numbers, but a house in a decent and capital growth neighbourhood to live in while using it as the seed generator for your real estate empire isn’t the worst way to get started. It’s important for Sam to understand that the house is not an asset itself, but could be useful. However, if he’s fully stretched just trying to make the minimum mortgage payments, he overpaid for it to begin with and it will be a decade before he can pull any money out, then it’s not a good position to be in.

Renting out rooms is a great option to help with all of this, but if it’s not really an option (I have 3 little girls and we won’t be renting out any rooms to strangers while I’m raising them…) then maybe sell. It depends on your market, but over here, it’s generally cheaper to rent in most of the nicer neighbourhoods than to own, so maybe create freedom in the budget by renting and skipping interest payments, property taxes, maintenance costs, etc. and us the money to get ahead. There are so many paths to success…

Hello Scott,
That was an intriguing article and yes I do track my Net Worth. However, I separate my assets based on liquid or non-liquid. For instance, we all know that an 401B – can only be used in emergency situations prior to retirement with a penalty. But, a traditional IRA has more flexibility and a penalty. When listing my assets one would be counted toward my net worth and the other no! I think that’s the one additional point I would add to the article assets that can be leverage for additional buying power.

I would never recommend renting over owning a home if the intent is to live there at least 5 years. Here is why?
– Even in poor cash flow areas the mortgage should not be much more than the associated rent.
– The mortgage interest can be written off on taxes. If we assume a 30% tax bracket (state and fed) then if you home expenditure (maintenance, mortgage, cap expenses, taxes, insurance) is no more than 30% greater than the rent you are monthly in a financially better position.
– Assuming a 10% equity position, a 1% property value gain is a 10% gain against the equity position.
– Each payment has a part that is applied to equity (assuming not an interest only loan).

I do not advocate over extending to purchase a home, but buying a home that is appropriate for your income is likely to not negatively affect anything and is likely to have a positive effect on traditional net worth calculation. Also if you sell the property when you retire early and downsize you will be able to access some of the equity that has accumulated in the home.

I don’t know whether to laugh or cry or give you a hug!…Great, great article! I learned these lessons above the hard way after I lost everything I had counted as an asset after a drawn out divorce. .. big old mortgaged house, big old slick cars.. I was young and dumb….I thought I was living the life:) the American dream….
Well…I had a BIG, Humongous forced epiphany in 2010….exactly as you say it….usable assets if one wants to be truly financially free….. Forward 2016, and I have an adequate but paid for home, 2 income producing paid of rentals, an adequate but paid for car… I am FREE!. Thanks for your great article!
Forward

Awesome article, Scott. You mentioned earlier that personal finance is personal; I agree. If you love your job, great; keep working to spend earned income on luxury items. The fact of the matter is that majority of people are looking for passive income either because they’re dissatisfied with their job or they want to enrich their financial life for whatever reason. If you want passive income, living within your means is mandatory through a good chunk of your REI career; which is not a bad thing at all. It really comes down to how bad you want passive income to help finance the life you truly want. Thanks for the great read.

I know it’s been mentioned a lot above but retirement accounts are accessible before age 59.5 and I personally am investing in them as well as looking to build cash for real estate assets (currently have the cash just having a challenge getting the right property…might be being too stingy on the offers). I’m looking to retire early and believe that retirement accounts play a role. I’m investing primarily in a Roth 401K and Roth IRA, knowing that I can pull the Roth money out anytime 5 years after opening it without a penalty. Similarly I plan to create Roth ladders with my pre-tax retirement assets once I retire early and am in a lower tax bracket (with income primarily being from rental properties). The earnings on the Roth investments will stay in the account until I am at retirement age and continue to grow proving money late in life when I can’t side hustle (which I will likely do in early retirement.

If I follow only the retirement account strategy I should be able to retire at age 42 this way, while also of course keeping expenses well below income earned. I’m hoping to use rental property to accelerate that timeline and retire even earlier allowing my retirement accounts to continue to grow in a tax advantaged way.

I completely agree with this article but wanted to bring up this point. It’s something I’ve spent many hours answering for myself. For most people retirement accounts are not for early retirement.

Great article! I could probably pick it apart and tell you why a short blog article doesn’t answer every financial question I’ve ever had. I could also tell you why one article doesn’t apply to every person on the planet. I will instead, choose to take the points that apply to me and thank the author for taking the time to try to help others out of the rat race.
I will also forward to some ‘Sams” that I know.